Proxy proposal irks both sides

The CSA aims to impose oversight on the firms that provide voting recommendations to shareholders on major proxy issues ranging from takeovers to compensation plans.

Critics of these firms and the role they play in Corporate Canada argue that the CSA’s effort doesn’t go far enough. Defenders of the existing system, on the other hand, agree that the CSA’s proposals probably won’t do much, but imposing these rules will impose needless costs.

In general, institutional investors, and the proxy advisory firms they hire, are content with the status quo. Corporate issuers are most concerned about the role that proxy advisors play and many favour regulation.

This fundamental divide is evident in the feedback that the CSA received on a consultation paper it published on the subject back in 2012. As a result of that consultation, the CSA declared that it believes a regulatory response is warranted. In particular, the CSA cited concerns about transparency, accuracy and independence in the proxy advisory business as reasons for regulatory intervention.

But rather than imposing rules to resolve these concerns, the CSA is pursuing a “policy-based approach,” which involves providing guidance designed to promote improved transparency in the workings of the proxy advisory firms and, hopefully, bridge the gap between the concerns of the “buy” side (institutional investors) and the “sell” side (investment bankers and their issuer clients) about the activities of proxy firms.

The CSA’s guidance is not meant to be prescriptive. Instead, it aims to give proxy firms some insight into what the regulators believe proxy firms should be thinking about when they devise their own policies and practices.

But, ultimately, it’s left up to the proxy firms’ clients, which typically are institutional investors, to decide whether the services of proxy firms are worth it.

Ordinarily, the financial services sector would applaud a proposed regulatory approach that takes a light touch and leaves the market as the ultimate arbiter of a business’s value. In this case, however, issuers and the rest of the sell side are complaining that the CSA’s approach won’t do anything to address their concerns about proxy firms.

This reaction is perhaps best captured in a comment letter to the CSA from John Budreski, a former investment banker, now an executive and director in the mining industry: “This policy as currently envisioned falls far short of what is required for the proper and healthy functioning of Canada’s public corporations and publicly traded markets.”

A number of the comment letters filed in response to the CSA’s proposals explicitly endorse Budreski’s comment, which argues that the current system is broken and mere guidance isn’t enough.

Budreski’s letter continues: “It is abundantly clear to any capital-markets participant that this proposed policy is about as light and unobtrusive as it could be. Much more is required.”

Defenders of the current role of proxy advisors generally agree that the CSA’s proposals probably won’t do much.

For example, the comment from the Canadian Coalition for Good Governance (CCGG), which represents the interests of institutional investors, suggests that the CSA’s proposed guidance mirrors what proxy firms are already doing voluntarily: “Without such policies and practices in place, proxy advisory firms could not survive and, accordingly, regulation appears unnecessary and a voluntary code of conduct the more appropriate route.”

Moreover, the CCGG comment says, the proposals aren’t likely to do anything concrete to change the way in which proxy firms operate or their role in the market, but will impose compliance costs all the same. This sort of regulation “is not desirable,” the CCGG’s comment says, “even if the regulation takes the form of guidance rather than being of a prescriptive nature.”

The CCGG’s comment says it’s not the lack of particular policies or practices at proxy firms that is causing complaints from issuers. Rather, it’s the basic function that proxy firms perform – providing advice to shareholders on contentious issues – that is the real source of criticism. And, the CCGG’s comment suggests, the CSA’s proposals won’t do anything to change that.

Conversely, issuers – and their allies on the sell side – are calling for more substantive regulatory intervention. As it stands now, the complaints of this group include: proxy firms have no accountability to the companies they cover; errors in their advice are common; and these shortcomings can be damaging to companies, shareholders and, ultimately, markets.

For example, in several comments from issuers, examples were provided about episodes in which these issuers received ultimatums on governance issues from proxy firms – criticizing the composition of their compensation plans, for instance – and were given only a day or two to respond.

In other instances cited by issuers, proxy firms’ recommendations appeared to be based on mistaken information and their advice often was based on large volumes of data that must be collected and analyzed within a short period of time (proxy season), which can involve proxy firms using what critics believe to be unqualified employees.

According to the comment from the Institute of Corporate Directors (ICD): “A significant source of tension between issuers and proxy advisory firms is the quality of analysis informing vote recommendations.”

The ICD’s comment also notes that there are concerns about the inexperience of the staff of proxy firms that are analyzing complex proxy issues: “Given the very high volume of vote recommendations prepared every proxy season by advisory firms, the risk for error is great. Indeed, we are aware of many circumstances where voting recommendations of proxy advisory firms contained mistakes and inaccuracies.”

Moreover, comments from issuers stress that the advice that proxy firms produce can have serious consequences, and that those recommendations may affect the outcome of a takeover vote or help to oust directors from a company’s board. Thus, according to these issuers’ comments, such opinions should be subject to certain standards of accuracy, transparency and independence – as are other forms of market information, such as company financials, equities research and press releases.

Critics of the role played by proxy firms put forth a variety of ideas for addressing these concerns – from ensuring a minimum proficiency standard for the analysts that help to formulate proxy firms’ recommendations to outright conflict-of- interest prohibitions in certain circumstances.

One of the primary recommendations to the regulators is to require proxy firms to share their opinions in advance with the companies they are providing advice about. This step would give issuers a chance to correct any factual errors that may be underlying the voting recommendations. And such a process also would facilitate dialogue between issuers and proxy firms.

The buy side, on the other hand, insists that proxy firms shouldn’t be forced to explain themselves to the issuers affected by the proxy firms’ recommendations. Comments on this side of the debate also point out that the advice from proxy firms doesn’t dictate their votes, and that the ultimate responsibility for those votes falls upon the institutional investors. Further, there are more important issues with the proxy-voting system that need regulators’ attention, which should be dealt with before any concerns about proxy firms.

According to the comment from Toronto-based money manager Northwest & Ethical Investments LP (a.k.a. NEI Investments): “Although we have some concerns about proxy voting advisory services, we would question whether this is the biggest priority for regulatory reform within the proxy-voting system.”

Given the pretty clear divide regarding this proposal, with issuers on one side of the debate and institutional investors on the other, it’s notable that a firm that falls into both camps – publicly traded Toronto-based fund manager CI Financial Corp. – favours the issuer perspective in its comment.

The CI comment says that in trying to walk the line between the diametrically opposed viewpoints of issuers and investors on this issue, the CSA’s proposal “disproportionately safeguards the interests of proxy advisory firms at the expense of providing adequate protection to both issuers and institutional investors.”

CI’s submission, which reflects its position as both an issuer and an investor, argues in favour of regulation: “We strongly believe that prescriptive regulatory oversight is required to maintain the integrity of the Canadian capital markets and the proxy-voting process, despite any potential impact that may result from the regulation of proxy advisory firms.”

CI’s comment suggests that proxy firms should be subject to regulatory oversight, as are other major market participants, and that proxy firms should face certain mandatory requirements, including that they: provide draft reports to issuers; explain the basis of their recommendations; and disclose any real or potential conflicts of interest in their recommendations.

Faced with sharply divergent opinions about whether any regulation is needed in the proxy advisory business, the CSA has attempted to find a balance that would mollify both sides.

But the compromise appears to be satisfying no one.

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